NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Liquidity Traps: An Interest-Rate-Based Exit Strategy

Stephanie Schmitt-Grohé, Martín Uribe

NBER Working Paper No. 16514
Issued in November 2010
NBER Program(s):   EFG   ME

This paper analyzes a potential strategy for escaping liquidity traps. The strategy is based on an augmented Taylor-type interest-rate feedback rule and differs from usual specifications in that when inflation falls below a threshold, the central bank temporarily deviates from the traditional Taylor rule by following a deterministic path for the nominal interest rate. This path reaches the intended target for this policy instrument in finite time. The policy we study is designed to raise inflationary expectations over time while at the same time maintaining all of the desirable local properties of the Taylor principle in a neighborhood of the intended inflation target. Importantly, the effectiveness of the potential exit strategy studied in this paper does not rely on the existence of an accompanying fiscalist (or non-Ricardian) fiscal stance.

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Document Object Identifier (DOI): 10.3386/w16514

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